The problem that has beset investors in most developed countries in the wake of the GFC is where to get decent returns. Especially if you are worrying, to use Deus Forex Machina’s distinction, about getting “a return OF your money as opposed to ON your money“. It has been less of a difficulty in Australia because interest rates have stayed higher. But investors should at least be thinking of diversifying their sources of investment and Deutsche is arguing that equities with high yield should be a focus:
Government bond yields have dropped markedly of late, and yields in Australia, the US and Germany are at 50-year lows. In contrast yields on offer in equity markets (whether earnings or dividend yields) look quite good. The elevated yield gap between equities and bonds should encourage flows into equities. Solid equity market gains historically follow a spike in the yield gap, and this is happening again this time The gap between equity and bond yields rose sharply in late 2011. Our work in December showed that equities have historically performed well (15%+) in the year following such a move. We update and add to this work, and show that the market has so far followed this pattern, and could have further to run.
Of course this may require taking losses, but then with bonds you can also have capital losses. The problem is, how real are the earnings forecasts? Deutsche is certainly bullish:
The forward earnings yield and the bond yield have typically moved together over time, both in the US and Australia. However, with bond yields falling lately and with equity valuations fairly modest, the valuation gap is around financial crisis peaks, suggesting equities are very cheap.
Deutsche’s model portfolio has a 26% weighting on materials and a 37% weighting on financials, which is disturbingly brave (especially the financials). Resources usually don’t have good dividend yields, and the banks are very high risk. And consumer discretionary (5%) is under pressure. Consumer staples are only 4.5% of the model portfolio, but they are perhaps safer. Deustche point is alright in a general sense, but finding trustworthy yields requires careful stock selection.